Accrual accounting is the method that recognizes revenue when it is earned and expenses when they are incurred, regardless of when cash actually moves. It is required under GAAP and IFRS and is the foundation for AR balances, DSO, and allowance calculations.
Accrual accounting is the method of recording financial transactions when economic activity occurs, not when cash is received or paid. Under the accrual basis, a company recognizes revenue at the point the performance obligation is satisfied (the customer receives the product or service) and recognizes expenses when the underlying resource is consumed. Cash flowing in or out of the bank account is a separate event that may happen days, weeks, or months later.
Cash basis accounting, by contrast, records revenue only when cash hits the bank and expenses only when cash leaves it. Cash basis is simpler and gives an unambiguous view of liquidity, but it distorts performance: a company that ships a large order on the last day of December and collects in January would show zero revenue for the year under cash basis, even though the work was done. Accrual basis fixes that distortion by aligning the income statement with the economic reality of the period.
For AR organizations, the difference is foundational. The accounts receivable balance only exists under accrual basis. Under cash basis there is no AR, no DSO, no aging bucket, and no allowance for doubtful accounts, because revenue is not recognized until the invoice is paid.
The matching principle is the conceptual backbone of accrual accounting. It states that expenses incurred to generate a specific stream of revenue must be recognized in the same period as that revenue. If a company recognizes one million euros of subscription revenue in Q2, the sales commissions, hosting costs, and customer success costs tied to that revenue must also land in Q2. Pushing those costs into Q3 because that is when the supplier invoice arrived would overstate Q2 margin and understate Q3.
Both US GAAP (specifically ASC 606 for revenue and ASC 326 for credit losses) and IFRS (IFRS 15 and IFRS 9) are built on accrual foundations. The SEC requires accrual basis for all publicly listed companies. Most jurisdictions also require accrual for tax purposes once a company crosses a revenue threshold. Without accrual, comparability across companies and periods collapses, which is why the major standard setters treat it as non-negotiable for any entity of meaningful size.
The order-to-cash function is full of accrual entries. On the revenue side, the most common AR accrual is unbilled revenue: a service has been delivered (or a milestone met) but the invoice has not yet been generated. The credit goes to revenue; the debit goes to unbilled receivables, which converts to standard AR once the invoice is issued.
Other AR accruals include the bad debt expense for the period, the corresponding update to the allowance for doubtful accounts (a contra-asset that reduces gross AR to its expected collectible value), and foreign exchange revaluation on open foreign-currency invoices at the period-end spot rate.
Deferrals run the other direction. Deferred revenue (also called unearned revenue) arises when a customer is billed or pays in advance for a service that has not yet been delivered. The classic example is an annual SaaS subscription billed up front: the full amount sits on the balance sheet as a liability and is released to revenue ratably over the twelve-month service period. Failing to defer would pull all twelve months of revenue into one period and badly overstate that quarter.
At month-end and quarter-end, the accounting team books a set of accrual journal entries to true up the books for activity that has not yet flowed through the operational systems. Typical entries include estimated unbilled revenue, accrued expenses (utilities, professional fees, commissions), prepaid amortization, depreciation, and accrued interest on debt.
Most period-end accruals are written as reversing journal entries. The original entry is recorded on the last day of the period, and an automatic mirror-image entry is booked on the first day of the next period. This reversal prevents double-counting once the actual invoice arrives or the cash settles. For example, if a controller accrues 50,000 euros of unbilled consulting revenue in March, the April reversal removes the accrual; when the actual April invoice is posted for 52,000 euros, only the net 2,000 euro variance hits April income.
Accruals are one of the highest-scrutiny areas in any audit because they are estimates and they affect the income statement directly. The most common errors include missing accruals (revenue earned but never accrued, which understates the period), overstated accruals (aggressive revenue pull-forward), incorrect or forgotten reversals (which double-count revenue or expense in the following period), and period mismatch (booking an accrual in the wrong month).
Auditors test accruals against materiality thresholds, look for supporting documentation (contracts, delivery confirmations, time sheets), and probe for evidence of management bias near period-end. Weak accrual processes are a leading driver of restatements and adverse SOX findings.
Modern accounting platforms apply continuous accounting and machine learning to reduce period-end risk. Instead of a manual scramble in the last three days of the month, transactions are accrued in near real time as contracts, delivery events, and operational data flow through. AI models can predict expected accrual amounts based on historical patterns and flag anomalies (a month-end accrual that is two standard deviations below the trend, or a recurring accrual that suddenly disappears). On the AR side, the same pattern applies to bad debt provisioning: rather than a flat percentage of receivables, expected credit loss models score each open invoice individually and roll up to a defensible allowance figure that ties directly to ASC 326 or IFRS 9 requirements.
Accrual accounting recognizes revenue when it is earned and expenses when they are incurred, regardless of cash movement. Cash accounting recognizes both only when money actually moves in or out of the bank account. Accrual gives a truer view of period performance; cash gives a clearer view of liquidity.
Both frameworks are built on the matching principle, which requires expenses to be recognized in the same period as the revenues they helped generate. Cash basis cannot deliver that match, so it produces financial statements that are not comparable across companies or periods. Accrual is therefore mandatory for any entity reporting under GAAP or IFRS.
The matching principle states that expenses incurred to generate a specific stream of revenue must be recognized in the same accounting period as that revenue. If revenue is booked in Q2, the directly associated commissions, fulfillment costs, and bad debt provisions must also land in Q2, even if the supplier invoices or write-offs arrive later.
An accrual recognizes revenue or expense before cash moves; the cash will arrive later. A deferral recognizes revenue or expense after cash moves; the cash arrived early and is held on the balance sheet until earned or consumed. Unbilled revenue is a common accrual; deferred subscription revenue is a common deferral.
Reversing entries prevent double-counting. The accrual estimates revenue or expense at period-end; when the actual invoice or cash settlement posts in the next period, the reversal cancels the estimate so only the actual amount hits the new period. Only the variance between estimate and actual flows through to the new period income statement.
AR balances and DSO only exist under accrual basis. DSO is calculated from accrual-recognized revenue and the accrual-basis AR balance, including unbilled receivables and net of the allowance for doubtful accounts. Switching the same business to cash basis would eliminate AR entirely and make DSO undefined.
